Federal ‘Payments Charter’ Threatens Turf Battle Between D.C. and the States
The idea of a limited federal charter specifically for nonbank payments companies appealed to top national bank regulators in both the first Trump and Biden administrations. But state banking regulators, who control licensing for money services businesses, even digital wallets, bridle at the suggestion they don't have the situation in hand already.
By Steve Cocheo, Senior Executive Editor at The Financial Brand
A curious regulatory turf confrontation may grow hotter next year once post-inauguration reality settles into the nation’s capital. What has been just a skirmish over regulation of nonbank payment companies to date could escalate into a full-fledged battle over the perceived need for a national limited-purpose payments company charter.
Part of what makes the friction curious is that the nexus of the battle in Washington, is the Office of the Comptroller of the Currency — past, present and, potentially, future.
Specifically, the basic concept of a federal payments charter was voiced by Brian Brooks, the Acting Comptroller in the latter part of the first Trump administration. Major banking associations made it clear they didn’t favor the idea.
But on multiple occasions, and as recently as post-election November testimony on Capitol Hill, the idea of a federal payments charter has also been backed by Michael Hsu, who has served as the Acting Comptroller for most of the Biden administration.
Hsu was on that occasion supporting pre-election statements by Nellie Liang, under secretary of the Treasury for domestic finance, concerning a payment charter in the context of modernizing the regulation of the U.S. payments business. Liang had said that "the existing regulatory patchwork is burdensome and inefficient, and at the same time does not adequately address risks to consumers and the financial system or promote competition and innovation by facilitating access to real-time payment systems."
A payments charter could be appealing to the returning Trump as a means of encouraging innovation in financial services, and shaking up the status quo. But that’s only half of the regulatory picture. The U.S. has a dual banking system and state agencies actually dominate the licensing, supervision and examination of nonbank payment companies.
The state banking regulatory system not only has a dog in the fight, but its dog has been growing in the payment space since 2018 — the Money Transmission Modernization Act, a model law on nonbank payments activities that’s been adopted in full by 22 states and in part in several more. This model law has the support, for now, of major fintech trade groups, including the Financial Technology Association and the American Fintech Council. The Conference of State Bank Supervisors, the association of state banking regulators, coordinated development of the legislation with the state-level regulators.
Complicating the debate over the creation of a federal payments charter is that proponents tend to invoke the bankruptcy of Synapse, the middleware company involved in banking as a service arrangements. For example, Michael Hsu has pointed to Synapse as an example of how financial services have been fragmenting and reforming and "the line between where a bank ends and where a nonbank begins is increasingly hard for consumers, regulators and market participants to discern."
Let’s also remember, though it is speculative, that Elon Musk, center of so much attention in Washington right now, has a history in payments, including being a key part of the formation of what became PayPal.
What the Comptroller’s Office Has Had to Say about a Federal Payments Charter
Banks have historically made up both the backbone and the guts of the payments system, and they have had a choice of federal or state charters, with all the regulation that goes with them. Money transmitters (or money services businesses), which not only include longstanding firms like Western Union money service but also newcomers like digital wallets and companies like PayPal, have had to rely on state-level licensing to operate in each jurisdiction.
Part of former Acting Comptroller Brooks’ interest came from his previous job with a payments company that did business in 50 states and that had to obtain 50 different state-level money transmitter licenses. At the time, this also meant complying with 50 different sets of rules. Brooks wanted to create a single point of regulation — a federal point of regulation.
Brooks also saw the fragmentation of financial services as inevitable, and in a 2020 interview he told The Financial Brand that "we need room enough in the banking charter to allow unbundled activities to stay within the OCC’s ambit." He also worried about safety and soundness as more financial risks leaked out of the banking system. Ultimately, the clock ran out as President Biden came in.
However, more recently the OCC has been championing the idea again. In a July speech, Acting Comptroller Hsu said that "the gap between state money transmitter licensing and prudential federal bank agency oversight is likely to become starker over time."
Continuing, Hsu said that backers of the state regulatory system "claim that this has enabled innovation. Perhaps. More clearly, however, it has enabled customer confusion."
Hsu said that fintechs "have been able to play fast and loose with how they market their services and their relationship to FDIC insurance, which does not cover their failures." He said he doubted that state-by-state regulation could address such risks.
"Tailored federal payments regulation and supervision is needed," said Hsu.
Read more: Will Nonbank Intermediaries Tip the Balance Towards Instant Payments?
Looking at the Law and How It Could Change
In the course of the speech Hsu supported part of his argument with legal concepts that have been under development by Dan Awrey, author of multiple books about financial services, including the forthcoming Beyond Banks: Technology, Regulation, and the Future of Money. Awrey is a professor of law at Cornell Law School.
In an abstract of a working paper, Awrey says the financial system is under stress: "The source of this stress is a new breed of technology-driven financial institutions, licensed and regulated almost entirely at the state level, that provide money and payments outside the perimeter of both conventional bank regulation and the financial safety net."
In a November interview on the Ballard Spahr Consumer Finance Monitor podcast, Awrey said that the idea of a federal payment charter "has kicked around Washington for at least 20 years" but hasn’t gained much traction. However, Awrey said that growing interest in a federal stablecoin charter could help pull along a federal payments charter. In fact, he suggested that the payments charter could take precedence, with the stablecoin activity becoming a permitted activity under the charter.
Currently, he said, nonbank payments players don’t operate with the same federal safety net that banks do — deposit insurance and more. If such a firm gets into trouble and files bankruptcy, consumer funds it has in hand become a claim on the bankruptcy estate. They become subject to delays and, potentially, shrinkage, according to Awrey. He noted that a large stablecoin firm, Circle, had funds tied up in the failure of Silicon Valley Bank but was backstopped because FDIC stepped in.
Awrey has been working on templates for a federal payment charter. One solution to the type of risk that Circle and its customers faced is to remove such accounts from the private banking system. Instead, companies with federal payment charters would have access to a Federal Reserve master account. The idea is that the Fed can’t fail, and that having a company like Circle "bank" with the Fed would cut out a middleman like SVB, Awrey explained. (A master account is an account in which a Fed district bank receives deposits for a financial institution, such as a bank or credit union.)
Awrey is honing two alternative approaches, embodied in the lengthy working paper. The first would be to federalize everything — bringing the dual banking system including a federal payments charter to an end— which he considers unlikely to happen, politically. He has indicated, however, that if such charters became reality, the Synapse model of BaaS would likely go by the boards. (Deep Dive: Read our exclusive excerpt from Jason Mikula’s book about BaaS.)
The second approach would impose several federal-level measures while leaving the structure of state-level money transmitter regulation intact. The approach would entail several steps and (in some cases) pre-empt state laws.
• One would regulate very precisely where the payment companies could place customer funds while they are in the firms’ hands, picking up on the idea of using Fed master accounts.
• Another step is exempting the payments companies from federal bankruptcy law, creating a resolution process that could be run by the Federal Reserve. The Fed would issue checks to people who had funds with the payment firms.
"Critically," wrote Awrey, "this federal resolution framework would supplant not only bankruptcy law itself, but also the patchwork of state-level security, surety bonds, insurance, and other consumer protection requirements that currently provide customers with uneven, and too often inadequate, protection."
• A third step would be making the firms under this regulatory approach eligible for access to the basic payments infrastructure routinely tapped by banks.
Beyond giving them Fed master accounts, rules would dictate that they could not be "illegally excluded from full participation in the bank-owned clearinghouses and other network infrastructure at the heart of the U.S. payment system."
In the paper Awrey acknowledges that this particular approach would not necessarily do away with the need to have a license in every state a firm wished to do business in.
Read more: Is the Future of Payments Public or Private? The Fed’s Waller Weighs In
States Counterattack on the Payments Front
In a 2023 CSBS podcast, Camille Polson, manager, policy development, explained that the model Money Transmission Modernization Act began with her group’s formation of a fintech advisory council in 2018. The intent of the model law is to create consistency in rules across the states adopting it. That in turn would enable consistency in supervision and regulation across participating jurisdictions.
"There is a value to doing things once, and doing them one time, correctly," said Polson.
Uniformity also eliminates issues of what laws and rules apply when someone, say, uses a digital wallet out of state, said Matt Lambert, deputy general counsel, policy, at CSBS in the same podcast. He explained that the model law stipulates that the laws of the state where the account is based govern the transaction.
In response to federal payment charter proposals and attacks on the state licensing system, CSBS issued a counterattack on nine what it called myths about the states’ approach.
"While targeted reforms made through cooperation between the states and federal government may be appropriate," the CSBS blog says, "a complete overhaul of an established, secure, convenient, and stable money transmission ecosystem is an unwarranted federal overreach."
Among the "myths" attacked in the blog: the supposition that variations in state laws allow money transmitters to make risky financial investments with customers’ funds; that state regulators can’t address risks that originate outside of their borders; and that a federal charter is necessary to enable innovation in payments. The blog also attacks assertions that the Synapse collapse illustrates why a federal payments framework overriding the state system is required.
The blog makes a key point: A money transmitter operating in any of the states that have adopted the model law is subject to everything in the law — "Not just the part of the company in that state … the whole company. As a result, more than 99% of the dollar amount of the industry’s money transmission is subject to [the model law’s] prudential standards."
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